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Look for companies with high-profit margins."
- Warren Buffet
One of the main objectives of businesses is making a profit. But what exactly is profit? And what are the different types of profit? Let's find out.
Profit reflects a company's financial gain after the deduction of costs, taxes, and other expenses from its revenue.
The distribution of profits is decided by the owners of the company. They can determine whether to distribute the profit among themselves or to use it for the company's growth. Generally, a mature company's profits are distributed as dividends and that of a fairly new company are used for the company's growth.
Gross profit is the profit a company makes after reducing the amount of money spent on producing the product from the money made from selling the product.
This is the first level of profit.
Sales - the amount of money generated by selling the product
Cost of goods sold - the total amount of money (cost) required to produce the product.
Operating profit is the profit after deducting operating expenses, and the amortisation and depreciation of assets from gross profit.
Operating profit is the second level of business profit. It includes the fixed cost and the variable cost.
Operating expenses are the ongoing costs for running the business.
Depreciation is an actual decrease of the fair value of an asset, such as a machine used for production.
Amortisation is the action or process of gradually writing off the initial cost of an asset.
Net profit reflects the residual income of the company after all the expenses and costs are deducted from the revenue.
It determines the overall profitability of the company and helps investors understand the effective management of the company. The net profit is commonly referred to as the profit of the company. This is the third level of profit.
Total revenue - total cash obtained by selling goods or services to buyers.
Total expense - total spending of a company.
All three types of profits are written in the company’s income statement.
Let's look at some examples to help understand all of these terms.
When a company (ABC Furnitures Ltd.) makes a total sale of £700,000 by selling 50 wooden tables which cost them £20,000 for production, their gross profit is:
£700,000 (Sales) - £20,000 (Cost of goods sold) = £680,000 (Gross profit).
When the gross profit is £680,000, operating expenses are £15,000, and the amortisation (£5,000) and depreciation (£7,000) amount to £12,000, then the operating profit is:
£680,000 (Gross profit) - £15,000 (Operating expense) - £5,000 (Amortisation) - £7,000 (Depreciation) = £653,000 (Operating profit)
Having an operating profit of £653,000, a total operating expense of £45,000, and tax expense of £23,000 the net profit is:
£653,000 (Operating profit) - £45,000 (Operating expense) - £23,000 (Tax expense) = £585,000 (Net profit)
Net profit is typically synonymous with net income.
Figure 1. ABC Furniture's Income Statement, StudySmarter
Profit calculation is important, as it helps us in understanding the financial value of a company.
The profit reflected in a company’s income statement does not reflect the amount of extra cash generated by the company.
Gross profit is the profit a company makes after reducing the amount of money spent on producing the product from the money made from selling the product.
Gross profit = Sales - Cost of goods sold
Operating profit is the profit after deducting operating expenses, and the amortisation and depreciation of assets from gross profit.
Operating profit = Gross profit - Operating expense - Depreciation - Amortisation
Net profit = Total revenue - Total expenses.
Profit means the money the company has generated is more than all the expenses spent on various activities of the company. The profit statement shows the business performance and helps investors understand the company’s efficiency to grow. The profits are shown in the company’s income statement in three levels, and give information about a company’s performance.
Profit can be defined as the financial gain the company realises when its revenue exceeds the cost and expenses incurred to generate this revenue.
Gross profit is the first level of profit that the company generates. This is the residual value when the cost of goods sold is subtracted from the amount of money generated from sales. Gross profit = Sales - Cost of goods sold.
The net profit reflects the residual income of the company after all the expenses and costs are deducted from the revenue. This is the third level of profit.
Profit or Net profit = Total revenue - Total expenses
Question
Complete the formula.
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Answer
Total expenses
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Question
What is the formula for?
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Answer
Gross profit
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Question
Complete the formula.
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Answer
Depreciation
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Question
Complete the formula.
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Answer
Gross profit
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